Hi All
For all those interesting in:
what happens to builders and developers when a market goes down like now,
the effect of this on supply and prices of IP
feel free to read this. it very long but spot on the money having been in the construction game for two booms. Points of note in bold.
Peter 147
article came from http://www.theaustralian.news.com.au/common/story_page/0,5744,11062748%5E25658,00.html
Working it outPaddy Manning
October 14, 2004
THEY say when the tide goes out, you see who's swimming nude. Now quite a few developers are looking exposed as the property market softens.
It's not a pretty sight. Distressed projects, bankruptcies, work-outs, even ASIC bans, dot the landscape and it's only the beginning.
No-one likes to point the finger, so people will rarely discuss specific cases. And there are few sources of hard statistical evidence around, including bankruptcy statistics.
As BIS Shrapnel chief economist Frank Gelber said: "It's been happening for a long time before you start to see it in bankruptcies."
As reported in The Australian last month, insolvency practitioners, including PPB, Ferrier Hodgson, and Sims Partners, have been gearing up for a new wave of work from the property industry.
Industry specialists contacted for this article agreed the incidence of distressed development projects was on the increase and predicted it would get worse.
Australian Institute of Quantity Surveyors general manager Terry Sanders said the forthcoming September quarter BRIX survey, which monitored the construction outlook, would show a levelling off in activity "pretty much across the board ... (but) more so with residential than non-residential".
Quantity surveyors often become involved when a project strikes trouble. They may be called in by the financier or developer to provide an independent estimate of the cost of work done to date, and what's required to complete the project.
Mr Sanders said market activity varied from state to state: "Victoria is still depressed, and things are starting to slow down in Queensland. Sydney, we're starting to see level off."
But wherever you look, most vulnerable are the smaller, often inexperienced residential property developers working on townhouse or unit projects in the $5million to $10million range.
Cliff Ventris, partner at quantity surveyors Haley Somerset Ventris, said: "The small, amateur guy who's done very well for the last few years, if they're not out of the market by now, there's a big boulder coming their way."
Mr Ventris specialises in litigation support, providing expert witness to court cases. He said trying to come to grips with the increase in distressed projects was like grabbing a "tiger by the tail".
"The market is tightening, there's no doubt about that. As it continues, builders find they cannot 'roll' their cash (from one job to another)," he said. "Subcontractors are even less able to look after themselves."
The common solution was for builders to simply put themselves into liquidation. Mr Ventris said this was the real frustration, "the way government allows people just to go under, and get away with it".
PPB's building and construction partner Mark Robinson said many inexperienced developers were not around during the last recession.
Oversupply was now catching up with these developers and many were failing to get the level of pre-sales necessary to allow them to draw down their construction finance.
He said the type of developer involved had come in five or six years ago and had been "making hay" ever since, rolling their profits into ever-bigger projects.
"They could now be looking at a $10 million to $15 million townhouse development," he said.
In a typical case, a financier of such a project would require pre-sales of 50 to 60 per cent of units but the developer might find they can only achieve 35 per cent - and probably for lower prices than expected.
Failure to meet pre-sale commitments leads the developer to resort to fourth and fifth-tier providers of mezzanine finance, often at very high interest rates. Or else the project comes to a complete halt, the site is sold, and the developer loses whatever money they spent getting development approval.
"At the moment in the marketplace there's not much of a premium on properties with a DA that haven't got construction finance," Mr Robinson said.
Still, there is a saying in the insolvency business that sometimes "your first loss is your best loss".
That is, if you press on to avoid taking a loss you might find your losses simply multiply. If finance is around and the project does go ahead, there can be a knock-on effect. If the developer is in too deep, there comes a point where they cannot pay their builder.
That's where PPB will become involved, arranging finance and construction to see the project through to completion.
Mr Robinson said "very sophisticated" investors in property, including private equity firms and even big listed companies such as Macquarie Bank and Stockland, might be willing to salvage failing developments.
They often offered to take out the bank that provided the original finance - but they demand an equity position in the project.
"They act as a bit of a white knight, but they want the lion's share of any upside," Mr Robinson said. It's known as a "participation fee".
"Somebody's loss is potentially somebody else's gain," he said.
Macquarie Bank has a portfolio of more than $1 billion - comprising senior debt, equity and mezzanine finance - funding developments such as residential apartments, land subdivisions and lifestyle projects.
Grant Munro, head of the bank's property finance division, said work-outs could be commissioned by project financiers, developers or appointed receivers.
He said that after a long period of price growth in the residential market, the next wave of busts, receiverships and work-outs was not yet upon us, but was around the corner.
"It's mainly to do with paying too much for land," he said. "When you get the squeeze between someone paying too much for land, and the expectation of valuation increases going on, but the double-whammy of cost increases, and then the expected realisations (ie. sales) from a project don't materialise ... it can create some stress."
All banks are wary of talking about problem projects, and Mr Munro said the proportion of irregular loans within Macquarie's portfolio was low: "The only evidence I have experienced is we actually funded somebody into a partially finished (Sydney) project they had bought from a distressed player."
The most difficult market is Melbourne. Berrick Wilson, partner at KordaMentha Real Estate Advisory, said the firm had dealt with more than a dozen property developments in difficulty in Melbourne in the past 12 to 24 months.
Mr Wilson said distressed projects were often driven by micro-market factors - at the level of the individual suburb - more than national or metropolitan trends.
While each project had different problems, the theme was inexperienced or under-resourced builders or developers taking on more than they could cope with in a super-heated market.
"Their business has grown very quickly, but management hasn't. Declining on-completion values have removed the safety net," he said.
The type of project most frequently in distress was smaller medium-density, suburban projects - under 50 units. Major banks had become more cautious about financing such projects.
Often it was the builder who went broke first after growing to take on larger projects "they think they can deal with" - like moving from building six townhouses in the suburbs to a 30-unit development with basement car parking and three levels.
"Suddenly they find themselves in difficulty. The builders go broke and the developer has to go back to the drawing board.
"When you've got a development that's mid-way through ... it's hard to get a builder to commit to a lump-sum contract," he said.
Mr Wilson said the pressure on builders was a function of the market, especially the high prices developers had been paying for land.
"Because sites have been getting more expensive, the first thing the developer does is turn around and try to squeeze the builder," he said.
Already this year, several companies have failed, including Consolidated Constructions and Centreline Construction, both in WA, and Brands Construction and Iezzi Constructions, both based in Queensland.
If a new builder had to come in to finish the job, it was the worst possible outcome, according to PPB's Mr Robinson.
Getting a new builder would add 30 to 40 per cent to the construction costs because, in signing off on the completed project, they would have to warrant the prior builder's work - for example, that the foundations were sound. The new builder would charge a significant premium to assume that risk. So the insolvency expert would try hard to renegotiate the original builder's contract.
"If dealing with a reputable, national builder, the likelihood of being able to strike a new deal is high. It's in both parties' interests."
For all those interesting in:
what happens to builders and developers when a market goes down like now,
the effect of this on supply and prices of IP
feel free to read this. it very long but spot on the money having been in the construction game for two booms. Points of note in bold.
Peter 147
article came from http://www.theaustralian.news.com.au/common/story_page/0,5744,11062748%5E25658,00.html
Working it outPaddy Manning
October 14, 2004
THEY say when the tide goes out, you see who's swimming nude. Now quite a few developers are looking exposed as the property market softens.
It's not a pretty sight. Distressed projects, bankruptcies, work-outs, even ASIC bans, dot the landscape and it's only the beginning.
No-one likes to point the finger, so people will rarely discuss specific cases. And there are few sources of hard statistical evidence around, including bankruptcy statistics.
As BIS Shrapnel chief economist Frank Gelber said: "It's been happening for a long time before you start to see it in bankruptcies."
As reported in The Australian last month, insolvency practitioners, including PPB, Ferrier Hodgson, and Sims Partners, have been gearing up for a new wave of work from the property industry.
Industry specialists contacted for this article agreed the incidence of distressed development projects was on the increase and predicted it would get worse.
Australian Institute of Quantity Surveyors general manager Terry Sanders said the forthcoming September quarter BRIX survey, which monitored the construction outlook, would show a levelling off in activity "pretty much across the board ... (but) more so with residential than non-residential".
Quantity surveyors often become involved when a project strikes trouble. They may be called in by the financier or developer to provide an independent estimate of the cost of work done to date, and what's required to complete the project.
Mr Sanders said market activity varied from state to state: "Victoria is still depressed, and things are starting to slow down in Queensland. Sydney, we're starting to see level off."
But wherever you look, most vulnerable are the smaller, often inexperienced residential property developers working on townhouse or unit projects in the $5million to $10million range.
Cliff Ventris, partner at quantity surveyors Haley Somerset Ventris, said: "The small, amateur guy who's done very well for the last few years, if they're not out of the market by now, there's a big boulder coming their way."
Mr Ventris specialises in litigation support, providing expert witness to court cases. He said trying to come to grips with the increase in distressed projects was like grabbing a "tiger by the tail".
"The market is tightening, there's no doubt about that. As it continues, builders find they cannot 'roll' their cash (from one job to another)," he said. "Subcontractors are even less able to look after themselves."
The common solution was for builders to simply put themselves into liquidation. Mr Ventris said this was the real frustration, "the way government allows people just to go under, and get away with it".
PPB's building and construction partner Mark Robinson said many inexperienced developers were not around during the last recession.
Oversupply was now catching up with these developers and many were failing to get the level of pre-sales necessary to allow them to draw down their construction finance.
He said the type of developer involved had come in five or six years ago and had been "making hay" ever since, rolling their profits into ever-bigger projects.
"They could now be looking at a $10 million to $15 million townhouse development," he said.
In a typical case, a financier of such a project would require pre-sales of 50 to 60 per cent of units but the developer might find they can only achieve 35 per cent - and probably for lower prices than expected.
Failure to meet pre-sale commitments leads the developer to resort to fourth and fifth-tier providers of mezzanine finance, often at very high interest rates. Or else the project comes to a complete halt, the site is sold, and the developer loses whatever money they spent getting development approval.
"At the moment in the marketplace there's not much of a premium on properties with a DA that haven't got construction finance," Mr Robinson said.
Still, there is a saying in the insolvency business that sometimes "your first loss is your best loss".
That is, if you press on to avoid taking a loss you might find your losses simply multiply. If finance is around and the project does go ahead, there can be a knock-on effect. If the developer is in too deep, there comes a point where they cannot pay their builder.
That's where PPB will become involved, arranging finance and construction to see the project through to completion.
Mr Robinson said "very sophisticated" investors in property, including private equity firms and even big listed companies such as Macquarie Bank and Stockland, might be willing to salvage failing developments.
They often offered to take out the bank that provided the original finance - but they demand an equity position in the project.
"They act as a bit of a white knight, but they want the lion's share of any upside," Mr Robinson said. It's known as a "participation fee".
"Somebody's loss is potentially somebody else's gain," he said.
Macquarie Bank has a portfolio of more than $1 billion - comprising senior debt, equity and mezzanine finance - funding developments such as residential apartments, land subdivisions and lifestyle projects.
Grant Munro, head of the bank's property finance division, said work-outs could be commissioned by project financiers, developers or appointed receivers.
He said that after a long period of price growth in the residential market, the next wave of busts, receiverships and work-outs was not yet upon us, but was around the corner.
"It's mainly to do with paying too much for land," he said. "When you get the squeeze between someone paying too much for land, and the expectation of valuation increases going on, but the double-whammy of cost increases, and then the expected realisations (ie. sales) from a project don't materialise ... it can create some stress."
All banks are wary of talking about problem projects, and Mr Munro said the proportion of irregular loans within Macquarie's portfolio was low: "The only evidence I have experienced is we actually funded somebody into a partially finished (Sydney) project they had bought from a distressed player."
The most difficult market is Melbourne. Berrick Wilson, partner at KordaMentha Real Estate Advisory, said the firm had dealt with more than a dozen property developments in difficulty in Melbourne in the past 12 to 24 months.
Mr Wilson said distressed projects were often driven by micro-market factors - at the level of the individual suburb - more than national or metropolitan trends.
While each project had different problems, the theme was inexperienced or under-resourced builders or developers taking on more than they could cope with in a super-heated market.
"Their business has grown very quickly, but management hasn't. Declining on-completion values have removed the safety net," he said.
The type of project most frequently in distress was smaller medium-density, suburban projects - under 50 units. Major banks had become more cautious about financing such projects.
Often it was the builder who went broke first after growing to take on larger projects "they think they can deal with" - like moving from building six townhouses in the suburbs to a 30-unit development with basement car parking and three levels.
"Suddenly they find themselves in difficulty. The builders go broke and the developer has to go back to the drawing board.
"When you've got a development that's mid-way through ... it's hard to get a builder to commit to a lump-sum contract," he said.
Mr Wilson said the pressure on builders was a function of the market, especially the high prices developers had been paying for land.
"Because sites have been getting more expensive, the first thing the developer does is turn around and try to squeeze the builder," he said.
Already this year, several companies have failed, including Consolidated Constructions and Centreline Construction, both in WA, and Brands Construction and Iezzi Constructions, both based in Queensland.
If a new builder had to come in to finish the job, it was the worst possible outcome, according to PPB's Mr Robinson.
Getting a new builder would add 30 to 40 per cent to the construction costs because, in signing off on the completed project, they would have to warrant the prior builder's work - for example, that the foundations were sound. The new builder would charge a significant premium to assume that risk. So the insolvency expert would try hard to renegotiate the original builder's contract.
"If dealing with a reputable, national builder, the likelihood of being able to strike a new deal is high. It's in both parties' interests."